Coyote Inc.operates three divisions.One division involves significant research and development,and thus has a high-risk cost of capital of 15%.The second division operates in business segments related to Coyote's core business,and this division has a cost of capital of 10% based upon its risk.Coyote's core business is the least risky segment,with a cost of capital of 8%.The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions.This approach will
A) favor projects in the core business division because that division is the least risky.
B) favor projects in the related businesses division because the cost of capital for this division is the closest to the firm's weighted average cost of capital.
C) favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them.
D) not favor any division over the other because they all use the same company-wide weighted average cost of capital.

Question

Quizplus · Accepted Answer

Using the firm's overall weighted average cost of capital (WACC) of 11% to evaluate projects in all divisions will favor projects in the research and development division. This is because the actual cost of capital for this division is 15% due to its higher risk. Evaluating these high-risk projects with a lower WACC (11%) makes them appear more favorable than they actually are, as the evaluation does not accurately reflect the division's higher risk and cost of capital.